Is Investing in Small Cap Crypto Ethical?

When you sell the minor cryptocurrencies, who’s holding the bag?

Disclaimer: I am not a financial advisor; this is not investment advice.

All About the Hype

Like many people, I got caught up in the recent stock craze around AMC, Nokia, BlackBerry, and Game Stop.

Due to my Charmin soft paper hands, I was quickly in and out of my meme stock positions. It will haunt me to my grave that I didn't hold.

So when the social media noise turned towards Dogecoin (a small but popular, cryptocurrency)I was ready to pull the trigger...but I didn’t.

Investing in cryptocurrency is becoming more mainstream. The most popular currencies, such as Bitcoin and Ethereum, have seen significant growth in value and frequently receive celebrity endorsement.

The increased attention has brought considerable criticism to the sector. Bitcoin, in particular, has been called a Ponzi scheme, accused of worsening climate change, and (falsely) accused of aiding crime.

But this article isn’t about any of those claims.

According to Investopedia, there are around 4,000 different cryptocurrencies available to purchase. There is a significant difference in market cap across the currencies.

I am generally supportive of the major coins. I believe they have a real chance at leveling the playing field for retail investors and democratizing finance. But I’m not as supportive of the smaller coins as an investment.

The meme stock craze was the first time I had ever really considered who was on the other side of a trade. And because of that, I think we need to consider if trading the lesser coins is the right thing to do.

Hot take: I don’t think it's ethical to trade the small-cap coins.

Here’s why.

What are we buying?

At a fundamental level, purchasing a share in a company entitles the buyer to:

• A claim against the assets of the company (cash, buildings, patents)
• A share of the firm's future cash flows (profits, revenues), and
• The hype (public sentiment, market optimism)

Typically we buy a company because we believe that one or more of those categories will grow in the long term. This will increase demand against the ticker, and with it will come an increased price.

Cryptocurrency is different. Its worth is based on other things like its use as a store of value. There is no underlying economic asset, and unlike traditional currencies, it is not based upon the taxing power and financial strength of a state.

Prices are likely speculative and based on:

• It becoming an accepted method of payment
• Blockchain technology being used in new and exciting ways, such as smart contracts.
• Its use as a store of value
• Scarcity
• Hype

This is the point in our journey where my problems begin. Large-cap crypto has already primarily achieved these characteristics. For a brief period of time, you could even use Bitcoin to purchase new Teslas (they’ve suspended that now due to the climate change issues).

But what about the smaller coins?

I find it difficult to believe that all 4,000 cryptocurrencies can achieve the first two characteristics. Deep down, we know that we don’t need 4,000 new currencies to replace the roughly 180 Fiat currencies currently in use.

The small-cap coins (and some of the more prominent)are too volatile to be an actual store of value.

Therefore, if there is no expectation of achieving the above characteristics, we are buying into the hope that the small-cap coin we picked will suddenly become the popular one.

So if that’s what we’re buying, what are we selling?

What are we selling?

There are many reasons why you might sell a share in a company. Its fundamentals might have changed, you might need capital elsewhere, or you might just be done with it. But when you do sell it, you are selling a real thing. That is, it represents a real thing. The buyer is purchasing it because they believe it is reasonably priced and can gain value from it.

Even if a share tanks and heads for zero, you can still sell it to a short seller who can benefit from the sharp price drop to close their positions. My point is that someone can typically find some value in a stock and purchase it to satisfy their particular needs.

But what about the small-cap crypto? If we accept my premise above, the only real value is the hype. So when you sell it, you pass the hype onto a new buyer.

You are selling FOMO.

Dogecoin is an excellent illustration of my point. Dogecoin had risen by 12,000 % this year, making it one of the largest coins by market cap. People are continuing to pour in, and the hype train is chugging along. That is, it was chugging along until Elon musk made a joke about it while hosting SNL. Then the value tumbled by almost half. How many people FOMO’d in at the top only to lose 40% of their investment in mere hours?

If we get off the train at the top, we will have left the buyer bag holding an asset that could potentially be worthless. And what is worse, we knew that its only value was hype when we sold it. The whole thing seems to be shaped like a triangular prism (note I do not include the major coins in this, see above).

Information asymmetry is a problem in all market transactions. But this is worse. We are actively hoping that someone will come along who has bought into the craze and convince them to take an essentially worthless asset off our hands under the belief that its popularity will increase exponentially. When the rocket fails to leave orbit and breaks up into a million pieces over the Pacific, who is left holding the bag?

What does Kantian ethics say we should do?

When making an ethical judgment on a situation, it is important to frame it within a theoretical framework. For this argument, I intend to use Kant’s Categorical Imperative.

Kant believed that “the rightness or wrongness of actions does not depend on their consequences” but on whether they fulfil our duty as moral beings.

You can find a detailed description of his theory here, but we can apply it fundamentally by asking ourselves two questions about the situation:

1. What if everyone always did what I intend to do, and it became universal law?
2. Were people treated as a means to achieve my ends?

If we apply our scenario to question 1, we arrive at the following statements:

• I intend to sell an asset to a buyer knowing that it has no intrinsic value other than its hype.
• If everyone did that, we would never know if what we're buying had real value beyond its superficial popularity.
• Confidence in the financial system would implode, and people would avoid investing in the crypto sector entirely.

Therefore, I do not wish this to be universal law, and I should not sell small-cap crypto.

Question 2 is a little more complicated.

• I am selling an asset that I know to have no intrinsic value to an unsuspecting buyer.
• I am using them as a means of profiting to my own end.

Therefore, I am not acting ethically when I sell to them because I am not treating them with respect, and I should not make the trade.

Question 2 is tricky because I am ignoring another vital concept, autonomy.

It is important to remember that human beings should be granted autonomy wherever possible. This means I should not interfere in their freedom to purchase an asset if they so choose. I should assume that they did their research and realize what they're buying and let them act in the way they desire — which hopefully is by allowing me to offload my shopping bags to them. Based on the principle of autonomy, it would be ethical to sell the coin, and it would be unethical not to sell it.

So should we trade small-cap crypto?

I don’t know, but I don't think so, at least not as an investment.

When it comes to any investment, we should ask ourselves who is on the other side of the trade. Our application of Kant’s Categorical Imperative shows enough ethical concerns that we should at least pause and think about it.

When we become purveyors of hype instead of traders in assets, we are left in a situation where our only profitable way out of a position is to hope someone with FOMO buys us out. We are no different than a poker player bluffing a lousy hand.

And I fold.

Disclaimer: I am not a financial advisor, and this is not investment advice. I am merely seeking to a start a philosopophical dialogue around the ethics of hype investing and small-cap crypto.